RBI issues new Guidelines for Micro Finance Lenders

Last Updated On: March 16, 2022, 9:12 a.m.
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RBI: Customers cannot be charged more Interest by Micro Finance Lenders

 

On 14th March 2022, The Reserve Bank of India (RBI) stated that Micro Finance lending Institutions cannot charge more interest from Customers.

The existing guidelines prescribe a maximum interest rate that a microfinance lender could charge on loans. This is 10-12 percentage points above the institution’s cost of funds, or 2.75 times the average base rate of the five-largest commercial banks, whichever is lower.

 

What is Micro Finance?

Microfinance is a way in which loans, credit, insurance, access to savings accounts, and money transfers are provided to small business owners and entrepreneurs in the underdeveloped parts of India.

The beneficiaries of microfinance are those who do not have access to these traditional financial resources. Interest rates on microloans are generally higher than those on traditional personal loans.

 

What are the types of Micro Finance?

  • Microloans - Microfinance loans are significant as these are provided to borrowers with no collateral. The end result of microloans should be to have its recipients outgrow smaller loans and be ready for traditional bank loans.
  • Microinsurance - Microinsurance is a type of coverage provided to borrowers of microloans. These insurance plans have lower premiums than traditional insurance policies.
  • Micro savings – Microsavings accounts allow entrepreneurs to operate savings accounts with no minimum balance. These accounts help users inculcate financial discipline and develop an interest in saving for the future.

 

What is the Importance of Micro Finance?

Microfinance provides access to capital for individuals who are financially underserved. If microfinance institutions were not offering loans to this segment of the society, these groups would have resorted to borrowing money from friends or family members. The probability of them opting for fast cash loans or payday advances (that bear huge interest rates) is also high.

Microfinance helps these groups invest wisely in their businesses, and hence, is in alignment with the government’s vision of financial inclusion in the country.

 

On Monday 14th March 2022, The Reserve Bank of India (RBI) stated that Micro Finance lending Institutions cannot charge more interest from Customers.

As per the statements issued by RBI, All microfinance lenders must now put in place a board-approved policy for the pricing of loans,  The policy should include a well-documented interest rate model and the different interest rate components, such as cost of funds, risk premium, and margin. It should also contain the range of spread of each component for categories of borrowers and a ceiling on the interest rate and all other charges applicable to the microfinance loans.

 

If an institution has access to low-cost funds, it can charge a low-interest rate. If an institution does not have recourse to the low cost of funds and borrows from non-bank lenders, it has the flexibility to charge a higher interest rate,"

RBI has also raised the annual household income level to ₹3 lakh for classification of eligibility to avail of microfinance loans, thus increasing the market size. Earlier, the income caps were kept at ₹.25 lakh in rural areas and ₹2 lakh in other areas.

The central bank has also put a limit on the maximum repayment value to 50% of the monthly household income to curtail over-lending to customers. Thus, if the household income is ₹3 lakh, the maximum loan installment that a borrower needs to pay cannot exceed ₹1.5 lakh per year. RBI also said that there would be no prepayment penalty on microfinance loans.

 

RBI in its new guidelines said that interest rates and other charges on these loans should not be kept very high. Because these fees and rates will be under the supervision of the central bank.

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